Federal Reserve documents 37 page

I also considered pegging interest rates on securities with two-year maturities or less. We could do that by buying and selling those securities at the rates we chose to target. This step would powerfully signal our commitment to keep rates low for at least two years. However, to make this work we might be forced to buy enormous amounts of securities. Our balance sheet might balloon out of control, a risk we were not willing to take—at least not yet.

We looked at starting a “funding for lending” program that would provide cheap financing to banks that agreed to increase their lending to small and medium-sized businesses. The Bank of England and the British Treasury would adopt such a program in July 2012. The idea of jump-starting credit for smaller businesses was appealing. (Sarah Raskin was a particularly strong proponent.) But U.S. banks had little interest in a funding-for-lending program. Unlike British banks, they had access to all the cheap funding

they could use and saw few opportunities that they were not already pursuing to lend profitably to small businesses.

A more radical idea, supported by many academics, was called nominal GDP (gross domestic product) targeting. I had discussed it with Don Kohn, Janet Yellen, and Bill Dudley before launching QE2 in 2010.† Under nominal GDP targeting, the central bank no longer has a fixed inflation target. Instead, when growth is strong, it shoots for lower inflation. When growth is weak, it seeks higher inflation. In 2011, with growth quite slow, nominal GDP targeting would have suggested a temporary inflation goal of 3 or 4 percent or even more.

Fundamentally, nominal GDP targeting seeks to change public expectations of how the central bank will behave in the future and thereby affect asset prices and interest rates in the present. In 2011, for instance, the adoption of nominal GDP targeting would have implied that the Fed was committed to keeping short-term interest rates low for a very long time, and perhaps to undertaking additional asset purchases as well, even as inflation rose. If markets believed that commitment, they would bid down longer-term interest rates right away, thus supporting current economic growth.

The full FOMC would discuss nominal GDP targeting at its November 2011 meeting. We considered the theoretical benefits of the approach, but also whether it was desirable, or even feasible, to switch to a new framework at a time of great economic uncertainty. After a lengthy discussion, the Committee firmly rejected the idea. I had been intrigued by the approach at first but came to share my colleagues’ reservations about introducing it at that time. Nominal GDP targeting is complicated and would be very difficult to communicate to the public (as well as to Congress, which would have to be consulted). Even if we did successfully explain it, other challenges remained. For nominal GDP targeting to work, it had to be credible. That is, people would have to be convinced that the Fed, after spending most of the 1980s and 1990s trying to quash inflation, had suddenly decided it was willing to tolerate higher inflation, possibly for many years. They’d have to be convinced that future Fed policymakers would continue the strategy, and that Congress would not act to block it.

But what if we succeeded in convincing people inflation was headed higher? That outcome, too, carried risks. Would people trust that future policymakers would have the courage and competence to quash inflation later, as the strategy dictated, even if doing so risked creating a recession? If not, nominal GDP targeting could increase fear and uncertainty about future inflation. Instead of spending and investing more, as hoped, households and businesses might become cautious and spend and invest less. Then the Fed could eventually find itself in a 1970s-style predicament—without credibility and with the economy suffering from both low growth and too-high inflation.

An idea related to nominal GDP targeting, but far easier to communicate, was simply increasing our inflation target to, say, 4 percent—without the commitment inherent in nominal GDP targeting to later bring inflation very low. People and businesses would spend more now, before prices went higher—or so the theory went. My former colleague at Princeton, Paul Krugman, would advocate that approach in an

April 2012 New York Times piece with the headline “Earth to Ben Bernanke,” accompanied by a drawing of me in a space helmet, looking clueless. (I was used to personal attacks by now, but I thought this one was more than a little unfair, since the Fed under my leadership had hardly been passive.) In my 2010 Jackson Hole speech, I had rejected a higher inflation target for many of the same reasons that would cause me to pull back from nominal GDP targeting. Whatever the benefits of higher expected inflation for growth—and they can be debated—raising people’s inflation expectations substantially, using only talk, is easier in theory than in practice.

Although we ultimately rejected the specific approach of nominal GDP targeting, we did not reject the general principle that shaping expectations about future policy can influence current financial conditions. We had already tried to provide policy guidance, for example, by saying in March 2009 that we expected rates to remain “exceptionally low” (in other words, near zero) for an “extended period.” As a next step, I pushed the Committee to replace the fuzzy “extended period” with a more specific phrase. At the August 2011 meeting, we said in our statement that we expected our federal funds rate target to remain low “at least through mid-2013”—that is, for at least two more years. The date was consistent with FOMC members’ economic forecasts and model-based analyses of when increasing rates might become appropriate. Three FOMC members—Richard Fisher, Charlie Plosser, and Minneapolis Fed president Narayana Kocherlakota—dissented, in part because they didn’t think the economy needed more monetary stimulus. Plosser also believed that using a specific date would suggest that we had flipped on the autopilot and would not change our target rate in response to countervailing economic developments.

I agreed that it would have been better to tie our policy plans more directly to conditions in the economy rather than setting a date. We make our policy decisions based on what’s happening in the economy, and tying our guidance to economic conditions would have given markets more insight into our thinking. But it would take time to forge agreement within the Committee about how best to do that. In any case, the change in our language seemed to work. Investors pushed out their expectations of the first short-term rate increase, resulting in lower long-term interest rates. After a while, though, as the recovery continued to disappoint, one drawback of date-based guidance became evident. As our expectation for the first rate hike moved further into the future, we were compelled to adjust our statement. After the January 2012 FOMC meeting, we said we expected exceptionally low rates “at least through late 2014,” and in September 2012 we would move the date out to mid-2015.

In the meantime, we had found a way to use our balance sheet to further depress long-term interest rates—without having to expand it. In September 2011, the Committee—with Fisher, Kocherlakota, and Plosser again dissenting—decided, by the end of June 2012, to purchase $400 billion of Treasury securities with maturities of six to thirty years. Instead of financing the purchases by creating bank reserves, however, we would sell an equal amount of Treasuries that we already owned, with maturities of three years and less.

We called it the Maturity Extension Program. The press, not quite accurately, nicknamed it “Operation

Twist,” after a Fed program of the same name during the early 1960s. Back then, under the leadership of William McChesney Martin, the Fed bought longer-term securities and sold shorter-term securities in an attempt to “twist the yield curve”—that is, lower long-term interest rates (to stimulate spending and investment) and raise short-term rates (to protect the value of the dollar, supposedly).‡ This time, our goal wasn’t to move short-term and long-term rates in opposite directions but to bring long rates closer to rock-bottom short rates. With so many reserves already in the banking system and our promise to hold rates at zero at least through mid-2013, we saw little danger that selling short-term securities would lead to a significant rise in short-term rates. Thus, we expected our purchases under the Maturity Extension Program to have effects similar to those of our purchases under QE2.

THE POLITICAL REACTION to the Maturity Extension Program was muted, at least compared with the reaction to QE2. In part that’s because the program involved no increase in bank reserves and was not vulnerable to the “printing money” charge. Nevertheless, on the eve of our decision, the four top Republicans in Congress released another letter criticizing our interventions. House Speaker John Boehner and Senator Minority Leader Mitch McConnell—and their deputies, Representative Eric Cantor and Senator Jon Kyl—called on us to “resist further extraordinary intervention in the U.S. economy.” I wondered who or what was behind the letter, since I had reasonably good relationships with all four of the authors and was always willing to discuss the economy and the Fed’s policies with them. Boehner in particular had supported my reappointment and had told me in private meetings that he was glad I had been at the Fed during the crisis.

Although the public reaction to our latest program was relatively mild, the political environment in general remained poisonous, in large part because of the ongoing contest for the 2012 Republican presidential nomination. Pandering to voters’ resentment and worry, the candidates tried to top one another in attacking the Fed and me personally. Former House Speaker Newt Gingrich said he’d fire me and called me “the most inflationary, dangerous, and power-centered chairman . . . in the history of the Fed.” (More mildly, the eventual nominee, Mitt Romney, said he’d “be looking for someone new.”) Texas governor Rick Perry won the Fed-bashing prize. In August 2011, at a campaign event in Iowa, he called our efforts to support economic growth “almost treasonous.” He added, “If the guy prints more money between now and the election, I dunno what y’all would do to him in Iowa, but we would treat him pretty ugly down in Texas.”

It was hard to ignore that kind of talk, and I worried that people would be misled by the absurd claims and charges (although when I heard what Governor Perry had said, I joked with staff members, echoing Revolutionary War firebrand Patrick Henry: “If this be treason, let us make the most of it”). The criticism wasn’t just from the right. The left-wing movement Occupy Wall Street, which sprang up in major cities during the fall of 2011, lambasted Wall Street bailouts, income inequality, and the lack of jobs. Its protesters camped near Federal Reserve Banks in Boston, Chicago, New York, and San Francisco. I told

the Joint Economic Committee in October that I couldn’t blame the protesters for being dissatisfied. “Certainly, 9 percent unemployment and very slow growth is not a good situation,” I said. I worried that the criticism would affect morale within the Fed, so I met with employees to make sure they had the information they needed to respond to questions from friends and neighbors.

Our means of combating high unemployment—stimulating demand by pushing down both short-term and long-term interest rates—got us in hot water with another politically influential group: savers. In 2007, before the crisis, retirees and other savers had been able to earn more than 5 percent on, for example, a six-month certificate of deposit. For most of the period after mid-2009, they were lucky to find a CD yielding as much as 1/2 percent. As I tried to explain at every opportunity, the fundamental reason that interest rates were low was that a weak economy can’t generate healthy returns on savings and investments. True, our policies pushed rates down even further, but we were doing that to promote economic recovery. Prematurely raising rates would only delay the time when the economy had strengthened enough to provide higher returns. And surely retirees would want a healthier job market as well, if only to prevent their twenty- and thirty-something children from moving back home.

Ironically, some of the same critics who said we were hurting savers also said that our policies were making rich people richer. (Since rich people save more than everyone else, apparently we were both hurting and helping these folks.) The critics based their argument on the fact that lower interest rates tend to raise prices for assets such as stocks and houses. Wealthy people own more stocks and real estate than the nonwealthy. However, this argument misses the fact that lower interest rates also reduce the returns that the wealthy earn on their assets. The better way to look at the distributional effect of monetary policy is to compare changes in the income flowing from capital investments with the income from labor. As it turns out, easier monetary policy tends to affect capital and labor incomes fairly similarly. Most importantly in a weak economy, it promotes job creation, which especially helps the middle class.

To get our story out and explain what we were doing and why, I continued to engage as much as possible with audiences outside of Washington and Wall Street, in venues rarely used by previous Fed chairmen. In November 2011, I visited Fort Bliss, in El Paso. On a frigid airfield at 4:00 a.m., I joined the base’s commanding general, Dana Pittard, in greeting 250 soldiers returning from Iraq. I also met with a group of soldiers and their families, who asked many thoughtful questions. I had the same impression I’d had in many other meetings: People were worried, and they just wanted to understand better what was happening in the economy and how it would affect them. Despite Perry’s prediction, I was not at all treated ugly in Texas. I returned home feeling renewed gratitude for the sacrifices of our troops.

In March 2012, I was invited to deliver a series of lectures on the Federal Reserve to undergraduates at nearby George Washington University. It felt good to be back in a classroom. I started my lectures with the founding of the Federal Reserve. I wanted the students to understand what a central bank does and that our actions during and after the crisis, though unusual in some respects, fit the historical purpose of the institution. I did an interview with ABC’s Diane Sawyer in conjunction with the lectures. We also made

the lectures broadly available, posting the videos and transcripts on the Board’s website. The following year, Princeton University Press published them as a book.

Later in 2012, I received an indication, of a sort, that our outreach efforts were succeeding. I was invited to attend Washington Nationals batting practice on September 7. Joe Espada, third base coach for the Nats’ opponent, the Miami Marlins, asked me to sign a ball, and Jayson Werth, the Nats’ hirsute six-foot-five right fielder, asked me, “So what’s the scoop on quantitative easing?” I was surprised but then I recalled that Werth was playing under a seven-year, $126 million contract, which gave him some interest in financial matters. (I kept the conversation on baseball.) Two days later, Richard Fisher received much the same question when after a concert he was introduced to cellist Yo-Yo Ma.

EUROPE’S FINANCES AND economy remained a mess through 2011 and into 2012, with effects spilling over into the U.S. and world economies. The staff of the Division of International Finance, now headed by Board veteran Steve Kamin, kept us well briefed. Kamin, an MIT-trained economist, had taken over from Nathan Sheets, another MIT grad, in August 2011. For me, one of the most important developments in Europe was a change in the leadership of the European Central Bank.

Jean-Claude’s term as ECB president ended on October 31, 2011, after eight years. I had acknowledged his remarkable run and thanked him publicly in August at the Jackson Hole symposium. We had worked closely together and with other central bankers to arrest the crisis. I did not agree with his support of austerity and tight money in Europe. Jean-Claude, who was not an economist by training, seemed to me to be too willing to accept the moralistic approach to macroeconomic policy advocated by many northern Europeans and too dismissive of policies aimed at raising total demand in a deep economic slump. But he was shrewd, and he excelled at the diplomacy required of him by Europe’s crisis. He was highly respected in Europe and around the world.

In the United States, the selection of a new Fed chairman is relatively straightforward. The president nominates; the Senate confirms. In Europe, however, ECB presidents emerge after a murky negotiation among the leaders of the major eurozone countries. Germany, the dominant economy, naturally expected to have a substantial say—even better, to be able to select a German national. However, the most plausible German candidate, Axel Weber, the head of the German central bank, had taken himself out of the running by resigning his post there in February. He was a staunch opponent of the ECB’s bond-buying program. He saw it as inappropriate and perhaps illegal central bank financing of governments.

The next most obvious choice was Mario Draghi of Italy. Soft-spoken, bespectacled, and scholarly, Mario earned his doctorate in economics from MIT, graduating two years ahead of me. (We knew each other there only in passing.) He had academic experience (as a professor at the University of Florence), market experience (as a vice chairman of Goldman Sachs), and public-sector experience (as governor of the Bank of Italy, among other posts). He also had led the Financial Stability Board (the successor to the Financial Stability Forum), which helps coordinate financial regulation among countries.

Draghi’s main problem was his nationality. Germany and other northern European countries might suspect that he would take the side of the debtor countries in making monetary policy or in fiscal disputes. But he smartly courted German media and public opinion, winning Chancellor Angela Merkel’s endorsement and thus the ECB presidency. I was delighted. I both counted him as a friend and saw him as a dedicated and highly qualified public servant.

Like Jean-Claude, Mario understood the ECB’s special role in the European power structure. And, within the ECB, he worked persistently to build alliances and to gain support for controversial measures. However, Mario—much more than Jean-Claude—was influenced by the New Keynesian framework that serves as the leading policy paradigm in the United States. That perspective made him more willing to push for expansionary policies to help the weak European economy. Indeed, one of Mario’s first actions was to reverse Jean-Claude’s interest rate increases of the summer. Europe nevertheless again lapsed into recession in the third quarter of 2011.

Draghi’s greater activism included ensuring that European banks had access to essentially unlimited cheap funding and pushing his colleagues for additional interest rate cuts. And, famously, in a speech on July 26, 2012, Mario bolstered market confidence and reduced pressure on weaker euro-area countries with the simple declaration that the ECB would do “whatever it takes to preserve the euro.” I took that to mean that, Bagehot-style, the ECB stood ready to backstop the debt of both countries and banks in the face of investor runs. Impressively, Mario’s statement was viewed as so credible that Italian and Spanish bond yields fell by about 2 percentage points by the end of 2012, without the ECB actually having to make any bond purchases. It was a marvelous example of the power of communication in central banking.

All of Mario’s steps went in the right direction, but, with fiscal policy creating even more powerful headwinds than in the United States, and stronger monetary measures (such as full-blown quantitative easing) facing stiff political resistance, European recovery remained elusive.

IN 2002, I had come to the Federal Reserve Board with the goal of increasing the Fed’s transparency and accountability—and, in particular, of instituting a numerical target for inflation by which the Fed’s performance could be judged. A little less than ten years later, in January 2012, I finally got my wish.

During that decade, the FOMC had debated inflation targeting many times. (Betsy Duke once quipped that she would gladly accept a target if only so she wouldn’t have to talk about it anymore.) By now, most FOMC participants supported, or at least did not object to, the approach. For most, Greenspan’s concern —that setting an inflation target would overly constrain policy decisions—had faded. In the difficult economic environment we confronted, clear communication was more important than flexibility. A numerical inflation target would signal both our strong resistance to deflation and our commitment to resisting too-high inflation.

However, since our mandate is set by law, moving forward required that we consult Congress and the administration. I had been doing that for some time. In January 2009, as the new administration was

preparing to take office, Don Kohn and I had met with Tim Geithner, Larry Summers, and Christy Romer in my office to discuss our adopting a target. They didn’t resist, but they saw the idea as a low political priority. Tim subsequently gave me a chance to explain it to President Obama in a meeting in the Oval Office. The president listened carefully and asked good questions. He told me that the Fed should do what it believed necessary.

But my well-rehearsed arguments failed to dent the skepticism of House Financial Services chairman Barney Frank. I had explained that an inflation target, if it increased businesses’ and consumers’ confidence in the Fed’s commitment to low inflation, would permit us to more aggressively loosen policy in support of job creation. Barney understood my logic, but he also understood the importance of political “optics.” He thought that the middle of a recession was the wrong time to risk giving the impression, by setting a target for inflation but not employment, that the Fed didn’t care about jobs. He would not support the change. After I reported the results of my consultations to the FOMC, we decided once again to put off any major change in our policy framework. Instead, in February 2009, we inched closer by releasing the range of Committee members’ individual projections under “appropriate monetary policy” for inflation, unemployment, and economic growth “over the longer run”—defined as roughly three to five years. That would give people a pretty good idea of where we were trying to steer the economy, without our explicitly adopting a target.

By early 2011, with the economy at least somewhat stronger, I thought the time had come to consider an inflation target once again. To emphasize the consistency of the approach with our dual mandate, I proposed that we introduce the target in the context of a broader statement that would make explicit our commitment to job creation as well as inflation control. Janet Yellen led a subcommittee, which included Charlie Plosser, Charlie Evans of the Chicago Fed, and Sarah Raskin. It developed a complete but succinct statement of our policy strategy. It set an explicit inflation target of 2 percent but emphasized that the Committee would take a “balanced approach” in pursuing both price stability and maximum employment.

The term “balanced approach” reflected the reality that the Fed’s employment and inflation goals can come into conflict at times—for example, when inflation is too high (calling for tighter monetary policy) but unemployment is also too high (calling for easier policy). In the past, Fed officials had been reluctant to talk about that, preferring to emphasize that low inflation tends to promote a healthy economy and job market in the long run. The new policy statement acknowledged that the two objectives, while “generally complementary,” could sometimes conflict in the short run, requiring policymakers to make a trade-off.

For example, if inflation was modestly above target but unemployment was very high, the Committee might choose to risk higher inflation as the price of bringing unemployment down.

I met in my office with Barney Frank, now—with Republicans controlling the House—the ranking minority member on House Financial Services. I explained our proposal, including our clear recognition of both sides of our mandate. He still wasn’t completely comfortable, but, based on our long working

association, he was willing to go along. It didn’t hurt that in the current environment no policy conflict existed: Both the low inflation and the high unemployment we were experiencing demanded easy monetary policy. I followed up my meeting with Barney with a dozen phone calls to congressional leaders. I knew from other consultations that Republicans would be okay with the statement. Many, like Congressman Paul Ryan of Wisconsin, had long supported an explicit inflation target.

The FOMC approved the policy statement and released it after the January 2012 meeting. Dan Tarullo abstained because he wanted more explicit language about the Committee’s willingness to accept inflation temporarily above target if needed to bring down unemployment. Thanks to the groundwork we had laid, and our incremental approach toward adopting an inflation target, we heard little criticism from Capitol Hill.

At the end of 2011, Barney announced that he would retire from Congress the next year. Dan Tarullo and I invited him to the Fed for a farewell lunch. Barney had been a good friend to the Fed and an effective legislator—and he was uproariously funny. Once, when he and I disagreed on a legislative tactic, and of course he was proven right, he left a message with my secretary. “Some people like to say I told you so,” it read. “Fortunately, I am not one of those people.”

IN THE MOVIE Groundhog Day, the character played by Bill Murray lives the same day over and over again. By the spring of 2012 we were beginning to feel the same about the economy. As in the earlier two years, the job market improved over the previous fall and early winter but then stalled, with unemployment plateauing a little above 8 percent. Housing remained a drag on the recovery, and although Europe seemed a little calmer, financial market volatility was also impeding growth. The headwinds were still with us.

We had estimated the unemployment rate consistent with full employment at about 5.5 percent. Despite three years of recovery, we were still far from that goal, and we weren’t optimistic about the prospects for faster progress. In June 2012, FOMC participants projected that unemployment, 8.2 percent at the time, would still be above 7 percent in the fourth quarter of 2014, more than two years later. Inflation, running slightly below 2 percent, was projected to remain below target in 2014.

At the press conference following the June meeting, reporters asked several times about the apparent contradiction between our policies and our expectation of glacially slow progress toward our employment and inflation goals. If we believed our own projections, shouldn’t we be doing more? I responded that we had eased policy considerably already. At that very meeting, for example, we had extended the Maturity Extension Program through the end of the year, which would result in additional purchases of $267 billion in longer-term Treasury securities, matched by sales of shorter-term Treasuries. I also repeated a point I had frequently made, that our unconventional policy tools, such as quantitative easing, involved costs and risks as well as benefits. It made sense to use unconventional tools less aggressively than more conventional tools like interest rate cuts.

My answers were not illogical, and they reasonably captured the collective view of the Committee. But I was dissatisfied. Our projections clearly showed that, without further action, reaching our goals for the economy could take years. And we couldn’t count on Congress for help. In fact, congressional gridlock presented a new problem. A “fiscal cliff” loomed at the end of the year. Without legislative agreement, the federal government would reach its borrowing limit, tax cuts enacted during the Bush administration would expire, and the sequestration (automatic, across-the-board spending cuts) would begin. I concluded we had to make faster progress toward our objectives and set about building a consensus among FOMC members for doing more.

Date: 2016-04-22; view: 559